S+B: What about the theory that the Fed kept interest rates too low after the dot-com crash, leaving too much money floating around, which migrated naturally into the mortgage market and created the conditions for the mortgage crisis. Is that too simple?
MELTZER: I don’t know. I really don’t know. At the time, you’ll remember that the Fed was very concerned about the prospect of deflation. I think they overestimated the risk. I discuss deflation at length in the first volume of my history of the Fed. The U.S. had about six periods of deflation and recession before 1950, and if you look at the data, for five of them the recovery from those recessions is indistinguishable from any other recession. The only bad one was 1929 to 1933. That was a case in which the Fed’s policy was deflationary. It was a very particular case. So the Fed’s concern about deflation after the dot-com bubble burst was just a policy mistake — one of many.
S+B: And the result of that mistake was an overly easy monetary policy that created the conditions for the housing bubble that followed?
MELTZER: The Fed kept money growth too high, too long, and interest rates too low, too long. Having said that, it’s important to add, as far as I’m concerned, that no one forced the bankers to make bad loans. That was their decision. So while the Fed was certainly a facilitator, the bankers were the ones who made the mistakes.
Returning to Growth
S+B: What is your view of the Fed’s monetary policy stance today?
MELTZER: I am not comfortable with the Fed’s current stance. The economy doesn’t seem to be in a recession, and if one does develop, it is not going to be a serious one. I think they were putting too much weight on the possibility of recession and too little weight on the prospect for inflation. I believe that the Fed panicked in January and February of this year, and overestimated the seriousness of what was happening. They talk about inflation, but talk is cheap. Back in the 1970s, Arthur Burns, then the Fed chairman, used to talk a strong anti-inflation game, but helped cause the largest peacetime inflationary episode in U.S. history. I think there’s a danger that we’re repeating those same mistakes.
In the 1980s and 1990s, under Paul Volcker and Alan Greenspan, the Fed managed to build its credibility and independence. Over the last few years, I fear that [current chairman] Ben Bernanke has thrown it away, and we are back where we were in the 1970s.
I think the current Fed will make some effort to deal with inflation, but not until after the presidential election. The Fed doesn’t like to act before the election, and has done it on only a very few occasions. The crisis atmosphere today makes it even less likely anytime soon.
The question is whether Congress will go along with an increase in interest rates of the magnitude that will be needed to bring inflation down. The inflation rate is currently around 4 or 5 percent, and that means you have to raise short-term interest rates up to 4 or 5 percent from 2 percent, where they are now, to have much of an effect. That’s a big move, and it’s hard to see it happening.
S+B: How much are increases in energy and food prices affecting inflation today?
MELTZER: Many economists and popular writers use the term “inflation” to refer to any increase in the price level. Like Milton Friedman, I define inflation as a sustained rate of change in a broad-based index. Food and energy prices, for me, are relative price changes. The only products of the Federal Reserve are money and credit. It cannot replace or supply oil or food. All it should do is make its best effort to prevent the oil- and food-price changes from becoming a reason for a sustained increase in the rate of price change. Alas, it has not done that.